That’s essentially what’s happening when treasury yields rise. And rise they have.
The US 10-year yield jumped 74 basis points in the year to October 29, and traded as high as 3.25 per cent earlier in October. That led markets to sell off aggressively.
It’s difficult to tell where the effects of a higher discount rate finished and growth fears for the future began. But both are likely to have had a hand in driving stock markets lower.
As it is, we took the chance to add to both US and UK 10-year sovereign debt as yields spiked in early October.
We are not piling into these bonds, but we thought it prudent to buy when the prices fell, given our positions are pretty light because of the low-rate environment.
We think the Fed must slow down, otherwise it could create a serious setback in the economy and markets.The cost of borrowing is just one of several costs that’s increased this year. Brent Crude at $80 is almost a fifth higher than at the beginning of the year, while American wage growth hit a nine-year high in September.
Then there’s a few hundred billion dollars more in tariffs that have been slapped on crossborder commerce involving the US.
President Donald Trump has been vocal in his belief that the Federal Reserve is moving too quickly. As unconventional as Mr Trump’s protests to an independent central bank are, we do have some sympathy for his view here.
While there have been some wild stories about American truckers getting paid $100,000 we think this is one of a few skills shortages, not a general upswing in wages. Pay cheques are growing barely in line with inflation.
We think the Fed must slow down, otherwise it could create a serious setback in the economy and markets.
Earnings have risen considerably this year, but price to earnings ratios have dipped recently. In some respects it’s quite healthy, given the significant upward move in all markets over the past decade.
Although, even as the US economy looks and feels like it’s going gangbusters, investors punish stocks for any misstep, regardless how minor.
The third quarter reporting season is a case in point. Half of the S&P 500 has reported and earnings growth is running at a punchy 22 per cent, according to FactSet.
But looking to the future has become decidedly murky. Almost twice as many companies have released lower sales growth guidance for the final quarter than have issued higher forecasts.
Amazon was probably the most prominent disappointment, warning that the Christmas season will deliver less revenue than first expected.
Even another hefty boost to profits wasn’t enough to placate investors – the shares slumped 10 per cent in a day.
We remain confident with the companies we hold, including Amazon. We bought more of the company as the share price fell abruptly. This is a quality business that is taking share from its rivals while also concocting new business lines to hoover up even more money from other companies.
A case in point is Amazon’s burgeoning advertising business which is expected to create more than £10bn in extra operating income by 2020.
Still, as much as we like the companies we own, we have been wary about the overall market for the past year or so.
We thought volatility could rise as investors became more nervous about rising interest rates and Mr Trump continued to play hardball over trade.
That’s why we’ve been buying safe haven currencies, such as yen and Swiss francs, gold and put contracts on the S&P 500.
We think sovereign bonds – particularly gilts – offer much less protection in market sell-offs than they have in the past. That’s why we’ve moved to creating a basket of diversifiers that gives us more comfort than expensive gilts would.
The Treasury market is critical now, we think. Aside from a recent slowdown in housing, the US looks very healthy.
Economic growth overshot expectations again in the third quarter, coming in 20 basis points higher than consensus at 3.5 per cent. It’s hard to see the wheels coming off the economy in the coming six months.
However, if the Fed overdoes its tightening, it could force a recession. Also, there’s an outside chance that China retaliates to American tariffs with the nuclear option: selling its hefty holdings of Treasuries.
Doing that would boost the supply of US debt, sending the borrowing cost for the US government and western companies significantly higher.
It’s a fiscally fragile time for the US. After splurging on tax cuts, the country is burning through 17 per cent more cash than a year ago and issuing more bonds to finance itself. It’s sold more bonds this year than in any of the last five.
A sharply higher 10-year yield could cause yet another fall in markets.
While we see this as but an outside chance, it reinforces why we’ve built ourselves a basket of defensive assets to dampen our downside during corrections like we’ve just seen.
David Coombs is Rathbones multi-asset portfolio funds manager
